Jun 4, 2013

The idea of Bitcoins is more than 4 years old. The idea of special drawing rights (SDRs) by IMF is more than 44 years old. Both are attempts at creating alternative currencies for different purposes.

SDR was created to help international trade tide away the exchange difficulties. SDR is not actually a currency, but a claim on currency, or a basked of currencies. Being internationally acceptable and with the ability to act as a medium of exchange, it has the potential to work as international reserve currency for trade. SDRs draw the legitimacy from the backing of IMF. How much backing the IMF has, especially when it comes to bringing SDRs to the center-stage of international trade, is moot. Probably the idea needs some development, and, the backing of USD supporters.

Bitcoin is virtual currency based on open source cryptographic protocol. It was introduced during Jan 2009. It is a peer to peer electronic cash system, and depends only on mathematical crypto-algorithms for its creation. There is a cap on maximum number of Bitcoins that will ever be generated at 21 million (by year 2040). This limiting cap might be a bad move, as Krugman helpfully points out. You can read more about how Bitcoin system works, here and here. Krugman has critiqued the idea here and here. Nevertheless, Bitcoins have done reasonably well for themselves and have achieved fair amount of acceptance in online transactions and black markets. Bitcoins have also undergone value fluctuations, crashes/recoveries, inflation etc, like any central bank backed paper currency. It is currently trading at around 120 dollars/Bitcoin. However, Bitcoins are not backed by any central bank or international authority. It is 'mined' virtually. Also, wider acceptance of Bitcoins in the real world is in question. Money is what people 'accept' as money. It might be gold, feathers, paper or Bitcoins. Bitcoins need time for acceptance.

Recent years have seen a lot of debate about Dollar being the prime global reserve currency. Also, competitive devaluation of currencies is being discussed after Abenomics of Japan, and the QE by the US's Fed. There are also nations who are not comfortable with US Dollar's pre-eminent position as reserve currency for international trade, e.g. Iran or Russia. Then there are currencies such as Euro, Yen, Renminbi, Pound and others. We do have multiple international currencies today but compared to USD, the share of others is low. About two thirds of world reserves are in USD, followed by around 20% in Euros and the rest is shared by all others. That means, the domestic problems of US is transmitted to the world through the reserve currency mechanism and there is hardly much that can be done as long as USD enjoys this position.

Here is what I propose. We can think of combining SDRs and Bitcoins. SDR as a concept is good. It has legal backing of IMF. And Bitcoin, as a technology, is great. A combination of Bitcoin and SDRs can create a good online currency that is tradable, liquid, and can be a good medium of exchange. The BitSDRs can be traded on regular exchanges and the base of BitSDRs can be determined by the IMF, based on the requirements of the international trade. A mechanism like SWIFT can be used for transactions between banks. That would de-link international reserve currency from getting affected by the domestic compulsions of one nation. Of course, the size of big economies like US will continue playing an important role on the BitSDRs too, but that would be determined purely by the terms of trade and not domestic problems. And so on. You got the drift.

Um...am I missing something? If it's this easy, there must be something wrong with the idea. Point it to me please.

Rejoinder, Dec 2013: Bitcoins have gained in value meanwhile. Countries are looking at it seriously, but none of them have banned them outright. Bangalore is the leading city in India in terms of Bitcoin transactions. There is a global bitcoins conference being organized in Bangalore on Dec 14 and Dec15, 2013.